Demand shock

Demand shock
See also


Demand shocks are certain events related to politics and other than changes in policy that have an impact on shifting the aggregate demand curve. Then the demand changes unexpectedly and rapidly. We distinguish between two types of demand shocks: positive (positive) and negative (negative). They are counted among economic shocks.

From time to time there are shocks in the economy (shocks) or distortions affecting economic dependencies that put the economy out of balance, and which may require policy response. Unpredictable events occurring in the economy are something ordinary. They are influenced by, for example: often inconsistent behavior of business people and the level of technical sophistication of the financial system. These disturbances may be temporary or permanent. It is difficult to distinguish them when they occur. Transient disturbances can be ignored because they will soon disappear.

The shock with respect to aggregate demand temporarily shuts the economy away from potential GDP and introduces it into a boom or recession. By gradually adjusting the price level, the economy finally returns to its normal state. The reason for the shocks are unexpected changes concerning, for example, fiscal and monetary policy of the state (mitigation or tightening), market participants' expectations about possible profits or revenues, increase in private or public expenses and changes in consumer preferences. Monetary and fiscal policy are important determinants affecting the shape and location of the aggregate demand curve.

Negative demand shock

It happens when there is a sharp drop in demand. As a consequence, the aggregate demand curve shifts to the left.

Consequences:

  • A fall in GDP below the potential level,
  • Lowering the price level (deflation),
  • Drop in the interest rate,
  • Short-term drop in supply,
  • Increase in investment expenses.

The process of gradual adjustment will continue until real GDP returns to the potential level. Investments will increase exactly by the amount by which they initially decreased. The interest rate will be low enough to stimulate investment. During a long period, real GDP will return to normal level, but during the period of gradual price adjustment the economy will go through the recession and rise in unemployment.

Positive demand shock

It happens when there is a sharp increase in demand. Then the aggregate demand curve shifts to the right.

Consequences:

  • Initial interest rate reduction,
  • Increased investment, exports and consumption,
  • Short-term increase in supply,
  • GDP growth and prices (inflation), resulting in interest rate rise.

Through this process of gradual adjustment of prices, the economy will finally return to its normal state. However, earlier it will go through the inflation period and the heyday of economic activity.

Policy response to demand shocks

  • Monetary or fiscal policy is able to compensate for the shock that affects the combined demand. The shift of aggregate demand to the outside or inside of the system may be reversed due to the policy in the opposite direction.
  • In general, the stability of aggregate demand is something desirable. However, the majority of economists say that active politics could increase instability instead of compensating for it. Monetarists are even opposed to launching a policy to counteract shifts in aggregate demand.
  • Other economists opposed to active politics believe that the policy of compensating for demand disruptions will have no impact on the Gross Domestic Product.

Demand shock and cyclical unemployment

The consequence of cyclical changes taking place in the economy is the demand shock connected with cyclical unemployment resulting from fluctuations in the productivity of the economy.

When the decline in demand for services and goods reduces the demand for labor, as a result of which the number of unemployed persons increases, while the number of vacancies decreases, we are dealing with a negative demand shock.

A negative demand shock, leading to an increase in unemployment, contributes to the process of depreciation of human capital. People who are just starting to enter the labor market find it difficult to find a job, consolidate knowledge and give them the chance to demonstrate their knowledge and professional skills. On the other hand, people who lost their jobs lose their acquired skills and professional qualifications over time. In addition, along with the rapid technological advancement, skills held by employees turn out to be outdated.All this reduces the human capital resources that the unemployed have, and thus the chance of finding a job decreases, which results in the unemployment rate remaining high.


Positive demand shock occurs at the time of economic recovery, when the demand for services and goods increases, which in turn has an impact on the increase in the number of vacancies, contributing to an increase in the number of working people and a drop in unemployment.


There may also be a structural shock on the market when the increase in vacancies is accompanied by an increase in the number of unemployed. This shock shows the low effectiveness of matches between the number of unemployed people and vacancies. The reason for the structural shock may be the modification of the production structure, which changes through the demand for new services and products, thus the business owners report a need for new employees with new skills and qualifications.


The demand-structural shock is a combination of the above-mentioned shocks. It comes to him when the change in the efficiency of the market is accompanied by a change in the relationship between the number of unemployed people and vacancies caused by economic activity

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